This post is part of a three-part series on maximizing net worth. In Part 1, we broke down common asset types into four main categories (cash, liabilities, liquid investments, and illiquid assets) and looked at the unique attributes that drive performance in each category. In this post, we will explore how changes in these underlying factors can affect your overall net worth.
If you are just catching up, be sure to check out my previous posts below:
Know Your (Net) Worth: A Guide to Tracking Your Total Assets
Maximizing Net Worth Part 1: Getting Under the Hood
Net Worth is a Moving Target
Your net worth performance is in many ways like the stock market. Both are moving targets based on many different factors, some more controllable than others. It is easy to get caught up in the day-to-day activity, especially in times when performance is particularly volatile or unpredictable. What you want to focus on instead though is the overarching trend over time.
You will inevitably hit some peaks and troughs over your lifetime, however, your ultimate goal should be to minimize the risk of a long-term downward trend. Thanks to the inventions of kale and avocado toast, we all stand to lead longer, healthier lives. Don’t outlive your pot of wealth in the process!
Diagnosing Changes in Net Worth
While there’s no need to obsess over every minuscule change in your net worth, you do want to take note of larger fluctuations or changes in trends over time. Understanding the root causes can help you make more informed and effective decisions on how to move forward.
There are three key things to consider when evaluating changes in your net worth:
Taylor’s net worth is $100,000 with the following asset allocation:
Cameron’s net worth is $100,000 with the following asset allocation:
In the same month, both Taylor and Cameron spend $10,000 and the S&P 500 index drops by 20%.
In this case, Taylor’s total net worth has decreased by $14,000 ($10,000 lost in spending and $4,000 lost in the stock market), or 14%. Both market conditions and spend attributed to this drop, however, his spending for the month had the highest impact.
Cameron’s net worth, on the other hand, has decreased by $26,000 ($10,000 lost in spending and $16,000 lost in the stock market) or 26%. Both market conditions and spend also attributed to this drop, however, market conditions had a much greater impact.
You can see how the same attributes (spend and market conditions) have vastly different outcomes based on each individual’s asset allocation. Understanding which factors have the greatest impact can help you hone in on the most important areas of focus.
All Good Things Can Quickly Come to an End
You may be thinking this post only applies to losses in net worth, however major gains in net worth should not be ignored either. A sudden spike can be a red flag as well, such as an overvalued stock that you are heavily invested in or extra cash that could be earning more interest. Upswings in net worth could pose an increased risk or alternatively, new opportunities to re-distribute your money.
Before you pop the champagne, make sure you understand the cause to protect, or possibly grow, your newfound earnings first!
Steps to Diagnosing Changes in Net Worth
1. Calculate your asset allocation
When you start to investigate the cause of fluctuations in net worth, you first want to look at your asset allocation based on the four main asset categories outlined in Part 1 (cash, liabilities, liquid investments, illiquid assets). You can use my Asset Allocation Workbook as a guide to get started using the links below.
2. Identify which attributes are driving each of your asset categories
In Part 1, we also broke down the common factors that drive the performance of each asset category, such as income, interest rates, and market conditions. Think about which ones are driving your own assets based on the types of financial accounts you own and your financial activity. For example, if you have a checking account and a student loan, these two asset types (cash and liabilities) are driven by spend, income, interest rates, and the loan amount.
3. Look for changes in these underlying attributes
Investigate if there have been any recent changes to the underlying factors that drive your asset categories. Here are a few examples:
4. Evaluate the impact of changes in these attributes
You may notice that multiple attributes have changed during the time your net worth has fluctuated. The impact of some may be larger than others though. Identify the ones that have the greatest influence based on the nominal value or percentage of growth/loss it had on your overall net worth.
Always Be Optimizing
Even if your net worth is chugging along just fine, it never hurts to check in once in awhile and see if you could be doing something better. Many attributes could be counteracting each other behind the scenes, such as the combination of a strong market and a high-interest loan, limiting the full potential of your financial assets. Optimizing your money during the good times is a great way to hedge against future downturns and the stress that comes along with it. Don't wait for things to go south to start taking action!
Staying in the Green
Once you have narrowed in on the key catalysts that are driving changes in your net worth, it’s time to decide if you need to take action. In Part 3, I will outline some key considerations to developing a strategic approach towards actively managing your money.
One of the key habits in building financial stability is to STAY ORGANIZED. Money can easily be left on the table because of forgotten assets or sub-optimal accounts. Make sure you know where your money is at and what is continuing to drive its value. Marie Kondo has nothing on you now!